UK Economy Looks Worse: Or Does It?

Its currency is strong against its closest neighbor, the euro, and the cost of its long-term debt is at almost Germanic levels. Yet, to many, the U.K. doesn’t feel like the safe haven this implies.

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There are several schools of thought on last week’s worse-than-expected GDP data, which suggested that the U.K.’s economy shrank by 0.7 percent in the second quarter of 2012 and led to several high-profile forecast downgrades.

Standard & Poor’s released a note reaffirming Britain’s triple-A rating Friday. On Wednesday, rival Moody’s cut forecasts for the U.K. and warned the government’s austerity timetable was becoming more and more difficult to stick to. It now predicts growth of 0.4 percent for this year and 1.8 percent for 2013.

The data, which suggested that the U.K.’s economy shrank by more than struggling Spain’s in the same period, has already been disputed. Economists scratched their heads over how to reconcile these numbers with more positive jobs data, and argued that the U.K.’s statistics body hadn’t factored in the effects of bad weather and the Jubilee public holiday.

“Economic growth in the U.K. is materially better than the official data indicate but — in the face of severe external headwinds — it is nevertheless weaker than we anticipated at the start of the year,” economists at Goldman Sachs wrote in a research note.

Others argued that the data is right, but analysts need to look for different reasons.

George Buckley, chief U.K. economist at Deutsche Bank, pointed out that the UK has had “fewer corporate bankruptcies than might have been expected given the fall in output.”

He added that there is some evidence of rising insolvencies — which could spell worse news for unemployment figures later in the year.

In the long term, concerns are growing about whether the U.K. financial sector can continue its strength if new regulations are imposed following scandals like the manipulation of the London interbank offered rate (Libor) and the mis-selling of payment protection insurance to consumers.

The lack of growth could also spell trouble for the coalition government, an increasingly uneasy-looking alliance of the Conservative Party and the Liberal Democrats.

Chancellor of the Exchequer George Osborne has seen his personal popularity slide along with the GDP numbers. A poll for Conservative Party websiteConservative Home Monday showed no respondents backing him to lead the party at the next election.

In contrast, London Mayor Boris Johnson, riding the wave of the Olympics, emerged as the leading contender to David Cameron.

The Bank of England’s Monetary Policy Committee is expected to have an uneventful meeting, with interest rates kept on hold and no further expansion of the quantitative easing (QE) program, at its meeting this week.

Goldman Sachs forecast a further 25 billion pounds in quantitative easing and a cut in interest rates from 0.50 percent to 0.25 percent in November, when the current QE program expires.

The Funding for Lending Scheme– where the Bank of England will lend money cheaply to banks in the hope that they will increase lending to consumers and small businesses – will start in August. Yet some, including economists at Goldman Sachs, are already arguing that the scheme is too cautious.

“A small amount of additional risk might be appropriate to ensure effective easing,” they wrote.

“We are critical of the scheme only to the extent that, in our view, it has not gone far enough.”